Concerns arise on derivative trading

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The Independent Online
CONCERNS HAVE emerged in the City that some dealings in the derivatives markets with building societies could be affected by the same legal problem as local authority swaps.

The societies are allowed to hedge risks using derivatives. But if they use such deals for pure speculation they could in theory be declared to be ultra vires, or outside the societies' legal powers. This was the reason local authorities were unable to honour swaps deals with City banks.

A legal risks review committee, headed by Lord Alexander, chairman of NatWest, yesterday recommended that the concept of acting ultra vires should be abolished for building societies, friendly societies, trusts and other similar entities.

But it dropped a recommendation in an interim report earlier this year that ultra vires should be abandoned where local authorities are concerned.

This is because the Government and the Audit Commission believe it important to have some legal restraint on councils as a way of improving accountability. The threat that councils could be found to be acting outside their powers is regarded as a useful discipline.

Market specialists said the legal risk in dealings with building societies was not an immediate problem. But City firms that deal with societies are nevertheless concerned that the law as it stands could leave them exposed in certain circumstances.

In particular, they have no means of checking whether individual deals with societies are for hedging or for speculation - which could prove ultra vires and thus invalid - and they want the position clarified.

Lord Donaldson, former Master of the Rolls, will be the first chairman of a new financial law panel to be set up as the key recommendation of Lord Alexander's committee. The panel has the financial backing of the Bank of England and the Corporation of London. About 75 City firms have agreed to contribute.

Its role will be to avoid repetitions of incidents such as the swaps fiasco. The panel will have its own secretariat.